Remarks before the 2015 AICPA National Conference on Current SEC and PCAOB Developments
Christopher D. Semesky, Professional Accounting Fellow, Office of the Chief Accountant
AICPA National Conference on Current SEC and PCAOB Developments
Dec. 9, 2015
The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author’s colleagues upon the staff of the Commission.
Good morning. I would like to address some recent considerations with respect to customer incentives, make a few observations about the new consolidation guidance, and end on a quick point about the impact of foreign exchange restrictions.
Within the past year, OCA has received consultations from registrants regarding the application of the customer payments and incentives guidance in Subtopic 605-50. As a reminder, that guidance provides that all payments to customers should be considered, and that the scope does not stop at the vendor’s direct customer, but explicitly includes other parties in the vendor’s distribution chain.
The proliferation of intermediaries in the technology sector that serve to connect vendors of goods or services with consumers has resulted in business models that did not exist when the customer incentive guidance was originally established. As a result, questions have arisen in practice regarding how the customer incentive guidance should be applied when evaluating whether payments made by a vendor outside the distribution chain should be considered to be net against revenue. For purposes of illustration, consider a vendor that develops a technology platform to facilitate its direct customer’s provision of revenue generating services. While the direct customer’s customer may also receive some benefit from the technology platform, that customer might not be considered in the distribution chain of the vendor because the direct customer does not pass along the services associated with the vendor’s technology platform to its own customer. One note of caution: careful consideration should be taken in similar arrangements to determine which party or parties would be considered the vendor’s customer.
In a similar fact pattern, the staff has not objected to a view that payments made to customers and potential customers of the vendor’s direct customers would be classified as an expense and not be evaluated under the customer payments and incentives guidance. In reaching this conclusion, careful consideration was given to whether: 1) the vendor was in substance granting a broad pricing concession to its customers; 2) there was a contractual requirement to pass along consideration to a direct customer’s customer; and 3) whether the vendor was acting as an agent of its customer in passing through consideration to a direct customer’s customer.
Subtopic 605-50 may not directly address the accounting for payments made outside of the distribution chain; therefore, reasonable judgment is required when evaluating whether payments made to a customer’s customer should potentially be accounted for as a reduction of revenue. We recently asked users for their views, and there was broad consensus that regardless of whether a company reported incentives gross versus net, clear disclosure of a registrant’s presentation policy, assumptions and alternatives was critical to the decision usefulness of the financial reporting.
Application of ASU 2015-02 – Consolidation
The next topic I would like to address is the evaluation of whether a decision-maker’s fee constitutes a variable interest under the FASB’s updated consolidation guidance. After considering a number of questions posed by registrants, I would like to share with you several observations regarding implementation of the new guidance.
For purposes of illustration consider an entity that has four unrelated investors with equal ownership interests, and a manager that is under common control with one of the investors. The manager has no direct or indirect interests in the entity other than through its management fee, and has the power to direct the activities of the entity that most significantly impact its economic performance.
In this simple example, if the manager’s fee would otherwise not meet the criteria to be considered a variable interest, the fact that an investor under common control with the manager has a variable interest that would absorb more than an insignificant amount of variability would not by itself cause the manager’s fee to be considered a variable interest. The guidance to consider interests held by related parties when evaluating whether a fee is a variable interest specifically refers to instances where a decision-maker has an indirect economic interest in the entity being evaluated for consolidation. However, in the instance where a controlling party in a common control group designs an entity in a way to separate power from economics for the purpose of avoiding consolidation in the separate company financial statements of a decision-maker, OCA has viewed such separation to be non-substantive.
In my example, if the manager determines that its fee is not a variable interest the amendments in ASU 2015-2 are not intended to subject the manager to potential consolidation of the entity. In other words, a decision-maker would not be required to consolidate through application of the related party tiebreakers once it determines that it does not have a variable interest in the entity.
I would also like to address the evaluation of whether a decision-maker’s fee arrangement is customary and commensurate. This evaluation is done at inception of a service arrangement or upon a reconsideration event, such as the modification of any germane terms, conditions or amounts in the arrangement.
The determination of whether fees are commensurate with the level of service provided often may be determined through a qualitative evaluation of whether an arrangement was negotiated on an arm’s length basis when there are no obligations beyond the services provided to direct the activities of the entity being evaluated for consolidation. This analysis requires a careful consideration of the services to be provided by the decision-maker in relation to the fees.
The evaluation of whether terms, conditions and amounts included in an arrangement are customarily present in arrangements for similar services may be accomplished in ways such as benchmarking the key characteristics of the subject arrangement against other market participants’ arrangements negotiated on an arm’s length basis, or in some instances against other arm’s length arrangements entered into by the decision-maker. There are no bright lines in evaluating whether an arrangement is customary, and reasonable judgment is required in such an evaluation. A decision-maker should carefully consider whether any terms, conditions, or amounts would substantively affect the decision-maker’s role as an agent or service provider to the other variable interest holders in an entity.
Foreign Exchange Restrictions
In the past year, OCA has observed registrant disclosures indicating a loss of control of subsidiaries domiciled in Venezuela. Disclosures indicate that these conclusions have been premised on judgments about lack of exchangeability being other than temporary and, also in some instances, the severity of government imposed controls. The application of U.S. GAAP in this area requires reasonable judgment to determine when foreign exchange restrictions or government imposed controls or uncertainties are so severe that a majority owner no longer controls a subsidiary. In the same way, a restoration of exchangeability or loosening of government imposed controls may result in the restoration of control and consolidation. In other words, I would expect consistency in a particular registrant’s judgments around whether it has lost control or regained control of a subsidiary. In addition, I would expect registrants in these situations to have internal controls over financial reporting that include continuous reassessment of foreign exchange restrictions and the severity of government imposed controls.
Further, to the extent a majority owner concludes that it no longer has a controlling financial interest in a subsidiary as a result of foreign exchange restrictions and/or government imposed controls, careful consideration should be given to whether that subsidiary would be considered a variable interest entity upon deconsolidation because power may no longer reside with the equity-at-risk holders. As a result, registrants should not only think about clear and appropriate disclosure of the judgments around, and the financial reporting impact of, deconsolidation but also of the ongoing disclosures for variable interest entities that are not consolidated.
Thank you for your kind attention.
 Subtopic 605-50 defines a customer as a reseller or a consumer, either an individual or a business that purchases a vendor’s products or services for end use rather than for resale. Customer includes any purchaser of the vendor’s products at any point along the distribution chain, regardless of whether the purchaser acquires the vendor’s products directly or indirectly (for example, from a distributor) from the vendor.
 ASU 2015-2, Consolidation (Topic 810) – Amendments to the Consolidation Analysis, was released in February 2015 and early adoption was permitted, including in an interim period.
 ASC 810-10-55-37D
 ASC 810-10-55-37